Tokyo Inflation Accelerates, Strengthening Case for BOJ Rate Hike

Annual core inflation in Tokyo accelerated for the third consecutive month in August, according to government data released on Friday. The reading, which serves as a leading indicator for nationwide price trends, adds to evidence of broadening price pressures and strengthens the case for the Bank of Japan (BOJ) to raise interest rates as soon as next month.

The Tokyo core consumer price index (CPI), which excludes volatile fresh food costs, rose 1.8% in August from a year earlier. This was slightly above market forecasts of a 1.7% gain and follows a 1.7% rise in July. The increase was driven by steady price gains in food items.

A separate index that strips out the effects of both fresh food and fuel—a measure the BOJ closely monitors as a gauge of underlying inflation—rose 2.0% in August, up from a 1.8% gain the previous month.

The data will be among the key factors the BOJ scrutinises at its policy meeting scheduled for September 17-18, when most market participants expect the central bank to raise its policy rate to 1.25%.

Economists point to several drivers behind the accelerating inflation. "A renewed escalation in the Middle East conflict is likely to push up energy costs with the subsequent second-round effects seen leading to broader price increases," said Masato Koike, senior economist at Sompo Institute Plus. "There's little reason for the BOJ to wait until October," he added, projecting a rate hike next month.

The BOJ raised its key interest rate to a 31-year high of 1% in June and kept policy steady in July, though it issued its strongest comments to date about mounting inflation risks. While government fuel subsidies have kept core inflation below target, a recent spike in wholesale inflation has highlighted pressure from the Middle East conflict, a weak yen, and robust AI-related demand.

"We're seeing broadening pass-through of costs from the Middle East conflict," including for daily necessities such as detergents and tissue paper, said Ko Nakamura, chief economist at Okasan Securities. He predicts nationwide core CPI to rise around 1.7% year-on-year in August.

Deputy Governor Ryozo Himino, while refraining from pre-committing to a September hike, stressed on Thursday the need for timely rate hikes and did not push back against dominant market bets of an increase next month. "We will examine, including at the next policy meeting, the likelihood of our baseline scenario materialising as well as risks," Himino told reporters, adding that discussions will account for the fact that underlying inflation was approaching 2%.

Attention now shifts to any comments from BOJ Governor Kazuo Ueda during his expected attendance at the G20 finance leaders' meeting next week in North Carolina.

Despite the broader price pressures, a private survey showed some firms struggling to pass on costs. The ratio at which companies were able to pass on rising costs to consumers stood at 39.9% in July, down from 42.1% in June, according to think tank Teikoku Databank. Smaller firms with limited bargaining power were particularly challenged in raising prices. "While companies may be passing on costs broadly, many of them may be resorting to only small price increases or hiking prices for a limited number of goods," Teikoku Databank said.